This post is for all the finance graduates who are wondering about opportunities that are present for them in Indian IT industry. There is very less awareness about the roles for finance graduate in IT. It is common perception that only role available is that of business analyst who acts as domain expert for financial sector and plays key link between business and software engineers. This business analyst is expected to work from requirement gathering to testing. But this is just operational role from IT organization perspective. Of course then there are also roles which are present in any company irrespective of the industry like one of financial planning and budgeting etc. But other than these there are other exciting and upcoming areas which I guess should interest most of the finance guys and which are present in most of the companies which have attained certain IT maturity.I intend to just highlight this broad area in my post.
Assuming a finance graduate joins an investment bank/fund house; his success would depend on his ability to manage his portfolio of assets such that he provides higher returns to his clients. This requires skill-set that enables him to perform valuation of different available assets and which I believe is the one of the most difficult part of his job. So is there any opportunity for the such person in IT industry ? Is there anything which could be as challenging as this? And my answer is yes. In fact gravity of problem increases than in financial sector. There the aim is to do valuation of asset and manage portfolio of assets which are mostly tangible and quantifiable but in case of IT one must do valuation of services and manage portfolio of applications. This is certainly more difficult since its intangible. If asked to draw parallel with equity then imagine yourself trying to value equity offered by newly formed company in some very new industry with no existing comparables. Imagine if someone was asked to value google as company in say 1980’s. Yes now I guess one would understand the gravity of problem trying to value intangible service. So why is it required in IT to do valuation of services? Its answer is very simple: - for its existence. It is very common problem which many CFO and CEO face today. They unable to understand where does the money for IT go? And moreover what tangible benefits does IT provide to the company. If you put in more MBA terms how does IT help in increasing shareholders value? You may like stakeholder instead of shareholder then I am fine with it too!! The problem is more aggravated when IT is horizontal servicing different business units. No business units are able to determine financial gains from IT services and economic downturn like this certainly makes them prune their IT budgets. So it is required to determine value of the IT services. Now the next question is how. This is most difficult since there has not been any Damodaran born in the industry to help them. Though there are certain guidance provided by different governing body but literature and research is much sparse compared to one available with financial sector. So I think this is one of most challenging areas for finance guys with bit of IT knowledge and strong business fundamentals to look forward for in IT industry.
I hope I pointed to some new areas for most of you guys who are not well versed with this industry and an opportunity for 2010 graduates. I know it doesn’t look as sexy as working in investment bank but for someone like me who passed out in 2009 and was forced to join IT industry it looks really exciting. From the day I joined industry my aim was to leverage my finance knowledge and provide new perspective in IT and am atleast satisfied that in my 6-7 months I have been able to research and work on this area. This is how I have made my knowledge relevant to my company and “am trying to create value for shareholder/stakeholders and who knows I may be damodaran in making for this industry." :)
This post is also answer to lot of questions which my friends are trying to figure out like what am I doing in an IT company. In fact one of them was shocked to know that even after MBA Finance I have rejoined IT industry. He glanced at me with a look as if I was black sheep in finance community and must be stripped of my degree. For him it was demeaning of the esoteric financial knowledge by working in an IT company . I hope that this awareness will help me to salvage some pride in eyes of such guys.
Showing posts with label IT. Show all posts
Showing posts with label IT. Show all posts
Derivatives in IT decision making
Doesn’t topic look strange? Yes I am referring to using derivatives in selecting IT solution. I haven’t got crazy working in IT industry after MBA finance but the fact is it relates. I read an amazing article from an analyst of Forrestor who had proposed this concept and I have highest respect for his knowledge and conceptual clarity of both the worlds – IT and Finance. So the credit for this post goes to him. I am trying in this post to explain my understanding of the report in simple words for benefit of non-IT guys.
Let me start with simple question – what does a business looks for from its IT? I know it may mean different to different businesses but in very crude terms we can say that IT must at very basic level facilitate the business to grow and thereby achieve its objective. Now the question for CIO is when business looks forward to IT for some solution to business problems he needs to select best from variety of alternatives available. This is very subjective since it has to take into consideration variety of constraints like budget, available skill set and future business outlook. But do all the necessary factors are factored in while making such decision? How is the cost-benefit done for each option? More often than not CIO would determine cost of implementation and the value of direct benefits from it and then select one which gives maximum value for given cost which should be within the budget. But is this the best way to take such decision? I will give simple example. Given business problem say introducing online shopping can be solved by solution A and solution B. Cost of solution A is say Rs 1 lakh while of solution B say 1.2 lakh which provides same functionality but with flexibility to add auction feature within a year. Now given above method of decision making CIO would select solution A since there is no way to factor the value of limited (time bounded) flexibility that solution B offers. So here if CIO is able to find the value of flexibility then he can make better decision. Then how to find its value?
The answer to this problem is call option from finance industry. This case is similar to concept of the call option which gives the buyer of the option a right to buy the underlying at strike price before expiry date of the option. Here also solution B offers CIO a right to implement auction functionality at certain determined cost within a year. The call options have value for the right they provide and similarly this flexibility should also have value. Call options price is found using Black Scholes option pricing formula:-
c= s*f(d1) –xe-rt f(d2)
d1={log(s/x) + (r + v2 /2)t}/v*sqrt(t)
d2 = d1 – v*sqrt(t)
where ,
s= price of underlying
x= strike price
r= risk free rate of interest
t= time duration for expiration of option
v = volatility for stock
f= standard normal cumulative distribution function.
We can use same formula to find value of the flexibility to make more informed decision since the concept is same. In our case
c= value of the flexibility provided
s= return on implementation of auction feature
x = cost of implementation of auction feature
t = 1 year here i.e. time available to avail the flexibility
v= volatility of industry can be used to predict volatility of business and hence technology usage.
So using this above option we can find value of this flexibility and that value can be deducted from option B to make it comparable with option A. This would enable better decision making for CIO than obvious methods that are used today. Further it provides him an opportunity to deliberate on future features that might be required and may facilitate him to provide more objective explanation to CFO for budgetary approval of flexible IT solution that may help business in longer term.
I know you may question lot of assumption like that of volatility and usage of normal distribution and most important the assumption made by Black-Scholes in pricing model etc. But this post is meant to bring to your knowledge entire new dimension of using the financial knowledge in IT decision making. We can always debate out the viewpoint and criticize the shortcoming of any model but at same time I think we should appreciate the new perspective.
Let me start with simple question – what does a business looks for from its IT? I know it may mean different to different businesses but in very crude terms we can say that IT must at very basic level facilitate the business to grow and thereby achieve its objective. Now the question for CIO is when business looks forward to IT for some solution to business problems he needs to select best from variety of alternatives available. This is very subjective since it has to take into consideration variety of constraints like budget, available skill set and future business outlook. But do all the necessary factors are factored in while making such decision? How is the cost-benefit done for each option? More often than not CIO would determine cost of implementation and the value of direct benefits from it and then select one which gives maximum value for given cost which should be within the budget. But is this the best way to take such decision? I will give simple example. Given business problem say introducing online shopping can be solved by solution A and solution B. Cost of solution A is say Rs 1 lakh while of solution B say 1.2 lakh which provides same functionality but with flexibility to add auction feature within a year. Now given above method of decision making CIO would select solution A since there is no way to factor the value of limited (time bounded) flexibility that solution B offers. So here if CIO is able to find the value of flexibility then he can make better decision. Then how to find its value?
The answer to this problem is call option from finance industry. This case is similar to concept of the call option which gives the buyer of the option a right to buy the underlying at strike price before expiry date of the option. Here also solution B offers CIO a right to implement auction functionality at certain determined cost within a year. The call options have value for the right they provide and similarly this flexibility should also have value. Call options price is found using Black Scholes option pricing formula:-
c= s*f(d1) –xe-rt f(d2)
d1={log(s/x) + (r + v2 /2)t}/v*sqrt(t)
d2 = d1 – v*sqrt(t)
where ,
s= price of underlying
x= strike price
r= risk free rate of interest
t= time duration for expiration of option
v = volatility for stock
f= standard normal cumulative distribution function.
We can use same formula to find value of the flexibility to make more informed decision since the concept is same. In our case
c= value of the flexibility provided
s= return on implementation of auction feature
x = cost of implementation of auction feature
t = 1 year here i.e. time available to avail the flexibility
v= volatility of industry can be used to predict volatility of business and hence technology usage.
So using this above option we can find value of this flexibility and that value can be deducted from option B to make it comparable with option A. This would enable better decision making for CIO than obvious methods that are used today. Further it provides him an opportunity to deliberate on future features that might be required and may facilitate him to provide more objective explanation to CFO for budgetary approval of flexible IT solution that may help business in longer term.
I know you may question lot of assumption like that of volatility and usage of normal distribution and most important the assumption made by Black-Scholes in pricing model etc. But this post is meant to bring to your knowledge entire new dimension of using the financial knowledge in IT decision making. We can always debate out the viewpoint and criticize the shortcoming of any model but at same time I think we should appreciate the new perspective.
